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APRIL 15, 2004
By Amey Stone Microsoft, the Value Stock? As the software giant matures, growth investors are finding less to like, while players who seek rebound plays are coming onboard Mutual-fund manager Carl Peterson isn't looking for hotshots in the portfolio he oversees for the Memorial Value Equity Fund (MVEIX ). The Wall Street pro employs what he calls a "reversion to the mean" strategy, explaining that he looks at the worst-performing stocks in the Standard & Poor's 500-stock index over the prior year to find companies with solid fundamentals that are out of favor with investors. "We buy the stocks that we feel are most prepared to rebound and have a reversion," he says. So, in late March, he bought Microsoft (MSFT ) for $24 and change. The king of software as a value-priced laggard? Strange but true. Microsoft was the 15th stock from the bottom in Peterson's ranking of the S&P 500 at the end of March. After rising about $1 since then, to close Apr. 14 at $25.50, Microsoft shares are flat with a year ago, while the Nasdaq is up nearly 50% in that time. The main culprit is slower growth at Microsoft, which averaged around 40% earnings increases annually in the 1990s but only in the single digits since then. A host of long-term issues weighing on the software giant haven't helped (see BW Cover Story, 4/19/04, "Microsoft's Midlife Crisis"). NEW BREED. Its flagship Windows operating system software upgrade has been delayed, open-source competitor Linux is making inroads, vexing security problems persist, and some of Microsoft's newest growth opportunities –- Internet services, wireless communications, and gaming –- have been frustratingly slow to add to the bottom line. The result is that Microsoft's shareholder base of growth investors is no longer all that enthused about the stock's prospects. Thanks to the tech rebound, analysts now look for long-term earnings growth in the mid-double digits. While that's an improvement over the first few years of this decade -- and certainly respectable for such a huge, mature company -- it may not be enough to keep Microsoft's traditional investors happy. Getting a new breed interested in Microsoft, as well known as it is, will take time, experts say. Microsoft "has been pure growth its entire history," says Howard Rosencrans, president of New York research boutique Value Advisory. "To transition out of growth portfolios and into value portfolios is something that doesn't occur overnight." CASH PILE. Indeed, it happens gradually. Value investors are starting to take note that Microsoft's latest results were decent, and execs have been quick to point out that the company is still growing faster than many of its well-known tech rivals. A rebound in PC sales and strong uptake of its Office 2003 release for its most recent quarter ended last December, helped Microsoft sales expand at a 19% pace. Earnings jumped 40% over the same quarter the prior year. For its fiscal year ended in June, Microsoft should have revenues approaching $36 billion, up from fiscal 2003 sales of $32 billion, a 12.5% jump. Analysts expect earnings (not including stock-option expenses, which Microsoft plans to include in future results) to come in at $1.20 per share, up from 92 cents in 2003, according to data from Thomson Financial. Microsoft also is sitting on a pile of cash that most analysts believe will be distributed to shareholders over the next year -- either in the form of a higher dividend or a one-time shareholder payout. The cash hoard continues to grow, to $53 billion at the end of 2003, up from $49 billion six months earlier. MONOPOLY MONEY. Shareholders could reap some of that cash sooner rather than later, now that Microsoft has settled a couple of significant lawsuits (although it continues to battle with the European Commission over antitrust issues). While some analysts are betting Microsoft will dole out a big chunk of that cash in a one-shot distribution, others think it could double or triple its current dividend rate of 16 cents. Given all that cash and the potential for a dividend hike, most Wall Street analysts conclude that Microsoft is a good buy. The consensus price target is $34, and its price-earnings ratio is 21, vs. 25 for the software industry, according to Thomson Financial. Even better, strip out that cash -- which amounts to nearly $5 a share -- and Microsoft is trading at a multiple of just 17. That's about equal to the S&P 500. For that, "you've got what is still the dominant player with a virtual monopoly on their market, whether they want to say they do or not," says Rosencrans. HIKE APPROACHING? Microsoft defends its growth prospects. CEO Steven Ballmer told BusinessWeek in a recent interview: "In no sense do I feel like we're past our prime." And plenty of analysts agree. "Just because a company is seeing a decline in its growth rate doesn't mean it's not a good investment," says John Linehan, portfolio manager of the T.Rowe Price Value Fund (TRVLX ). He has been adding to his Microsoft position for the past six months, and the stock now ranks among his top 10 holdings. Richard Moroney, editor of newsletter Dow Theory Forecasts, has recommended Microsoft for the past year, but he's increasingly frustrated that management hasn't raised the dividend yet. "If they really want to get some cash, why not raise the dividend rather than constantly selling their shares?" he asks, referring to insider sales by execs. Many investors believe that by settling lawsuits with Sun Microsystems (SUNW ) and InterTrust Technologies in recent weeks, Microsoft is clearing the way for a dividend hike. If it doesn't make a payout, that could be a risk near-term, especially for value investors hopeful for a higher dividend. An opportunity to announce a dividend hike is approaching: Microsoft plans to announce its fiscal third-quarter results on Apr. 22. "VALUE PICKUP." When fund manager Peterson bought Microsoft, it was with a longer-term horizon, betting the stock will climb to $35 or $40 over the next three years. That's not the kind of share-price doubling that growth investors look for, but as he says, "there's potential for a good value pickup." That means even with earnings growth likely to come in well below historic rates, Microsoft is probably not going to hurt investors any time soon. What kind of investors it has, however, is the real question.  With Spencer Ante in New York Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist Edited by Beth Belton
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